A special order is a job executed against customers specifications as to design,
model, size of the product. For pricing this special order or job, a cost sheet is prepared on the basis of material requisition, time taken workers and ration al methods of overhead obsortion. Thus total cost of job is arrived, to which if we add a reasonal profit as agreed, we will get price of a special order is arr ived. Process of product addition and Deletion: A business may have to decide on adding or dropping a product line. When a new p roduct line is added, certain costs will go up and vice versa, when a product li ne is dropped certain costs will not have to be incurred. Such a decision may be taken by comparing the differential cost and incremental revenue and its effect on the overall profit position of the company. Addition OR Expand of a the product: Expansion of business operations results in economies of scale, greater flexibil ity, lower fixed costs and greater capacity of the firm to meet the customers, s pecifications. Expansion also brings with it many organizational and communicati on problems control and monitoring functions become more complex and designation of authority and responsibility becomes more confused. Since profit maximization is a firms primary goal, the expansion of business ope rations should also be viewed from that angle. Expansion resuls in heavy fixed c osts. It means sales volumes will have to be increased for meeting such costs th rough there may be increase in per unit contribution on account of economies of the scale. The management must therefore make sure that market will absorb the a dditional volume of required sales. Illustration - I A comapnay is considering expansion. Fixed costs amount to Rs. 4,20,200 and are expected to increase by Rs. 1,25,000 when plant expansion is completed. The pres ent plant capacity is 80,000 units a year. Capacity will increase by 50% with th e expansion. Variable costs are currently Rs. 6.80 per unit and are expected to go down by Rs. 0.40 per unit with the expansion. The current selling price is Rs . 16 per unit and is expected to remain same under either alternatuve. What are the break even points under either alternative> Which is the better and why. Solution: Computation of break - even - point under the two alternatives Particular Present Position After Expansion Fixed cost Rs. 4,20,000 5,45,000 Capacity 80,000 1,20,000 Selling Price Per Unit 16 16 Variable Cost per Unit 6.80 6.40 Contribution per unit 9.20 9.60 (Sales - VAriable Cost) B.E.P in Units 4,20,000 / 9.20 5,45,000 / 9.60 45,652 56,771 Assuming that the whole production can be sold the profit under the two alternat ives will be as under. Particulars Present Position After Expansion Sales Rs. 12,80,000 19,20,000 -Variable Cost 5,44,000 7,68,000 Contribution 7,36,000 11,52,000 Fixed Cost 4,20,000 5,45,000 Profit 3,16,000 6,07,000 It is obvious from the above calculations, that profits will be almost doubled a fter the expansion of the product. Hence the alternative of addition is preferab le. Deletion Or Discontinue of a product: The following factors should be considered before taking a decision about the di scontinuance of a product line. 1. Fixed costs are apprortioned over different products on some reasonable basis . Which may not be very much correct. Hence contribution gives a better idea abo ut the profitability of a product as compared to profit. 2. The capacity utilisation i.e. whether the firm is working to full capacity or below the normal capacity. In case a firm is having idle capacity, the producti on of any product which can constribute towards the recovery of fixed cost can b e justified. 3. The long - term prospects in the market for the product. 4. The effect on sale of other products. In some cases the discontinuance of one product may result in heavy descline in sale of other products affecting the ov er all profitability of the firm. Illustration - II A manfacturer is thinking whether he should drop one item fom his product line a nd replace it with another. Below are given his present and ouput data. Product Price Variable Cost Percentage of sales Book Shelfs 60 40 30% Tables 100 60 20% Beds 200 120 50% Total Fixed Cost Per Year = Rs. 7,50,000 Sales last Year = Rs. 25,00,000 The change under consideration consists in dropping the line of tables in favour of cabinets. If this dropping and change is under the manifacturer fore casts t he following cost and output data. Product Price Variable Cost Percentage of sales Book Shelfs 60 40 50% Cabinets 160 60 10% Beds 200 120 40% Total Fixed Cost Per Year = 7,50,000 Sales This Year = 26,00,000 Is this proposal to be accepted? Solution: Comparative Profit Statement: Existing Situation Book Shelfs Tables Beds Total Sales 7,50,000 5,00,000 12,50,000 25,00,000 Less Variable Cost 5,00,000 3,00,000 7,50,000 15,50,000 2,50,000 2,00,000 5,00,000 9,50,000 Less Fixed Cost 7,50,000 Profit 2,50,000 Proposed Situation: Book Shelfs Cabinets Beds Total Sales 13,00,000 2,60,000 10,40,000 26,00,000 Less Variable Cost 8,66,667 97,500 6,24,000 15,58,16 6 4,33,333 1,62,500 4,16,000 10,11,833 Less Fixed Cost 7,50,000 Profit 2,61,833 Suggestion: The above analysis shows that the manufacturer will stand to gain in case he dro ps the production of tables in preference to cabintes. However the demand for ca binets should be of permanent nature. Working Notes: Variable Cost: Existing Situation Proposed Situation Book Shelfs 7,50,000 * 40/60 13,00,000 * 40 / 60 5,00,000 8,66,667 Tables 5,00,000 * 60/100 3,00,000 Cabinets 26,00,000 * 60 / 160 97,500 Beds 12,50,000 * 120 / 200 10,40,000 * 120 / 200 7,50,000 6,24,000 Illustration III: A comapny annually manifactures 10,000 units of a product at a cost of Rs. 4 per unit and there is home market for consuming the entire volume of production at the sale price of Rs. 4.25 per Unit. In the year 2003, there is a fail in the de mand for home market which can consume 10,000 units only at a sale price of Rs. 3.75 per Unit. The analysis of cost per 10,000 units is: Materials 15,000 Wages 11,000 Fixed Overheads 8,000 Variables Overheads 6,000 The foriegn market is explored and it is found that this market can consume 20,0 00 units of the product if offered at a sale price of Rs. 3.55 per Unit. It is a lso discovered that for additional 10,000 units of the product cover initial 10, 000 units. the product overheads will increase by 10%. Is it worth while to try to capture the foriegn market. Statement Showing the advisibility of selling goods in foreign market. Particulars Year 2002 Year 2003 Forien Market Total 10,000 Units 10,000 Units 20,000 Units 30,000 units Materials 15,000 15,000 30,000 45,000 Wages 11,000 11,000 22,000 33,000 Over Heads Fixed 8,000 8,000 1,600 9,600 Variable 6,000 6,000 12,000 18,000 Total Cost 40,000 40,000 65,000 1,05,600 Profit / Loss 2,500 (-) 2,800 5,400 2,600 Sales 42,500 37,200 71,000 1,08,200 Suggestion: From the above analysis it is clear that it is advisible to sell goods in the fo reign market. It will compensate not only for the loss on account of sale in dom estic market but will also result in an overall profit of Rs. 2,600. Working Notes: Sales: Year 2002: 10,000 * 4.25 = 42,500 Year 2003 : Home Market: 10,000 * 3.72 = 37,200 Foriegn Market: 20,000* 3.55 = 35,500 Overall Profit = Foreign Market Profit - Home Market Loss: 5,400 - 2,800 = 2,600 0 Make or Buy Decisions: Decision to make or buy has to be taken when product being manufactured has a co mponent part that can either be made within the factory or purchased from an out side firm. This decision can be arrived at only by comparing the suppliers price with the marginal cost. For example the toal cost of making a component part co mes to Rs. 11, consisting of of Rs. 8 as variable cost and Rs. 3 as fixed cost. Suppose an outside firm is willing to supply the same component part at Rs. 10. The prime fact conclusion is that it is cheaper to buy the component part. But a study of cost analysis above shows that each unit of component contributes Rs. 3 towards the recovery of fixed cost. This fixed cost has to be incurred to make or buy. The real cost in making one unit of component is only Rs. 8 which is it s variable cost. The offer should, therefore be rejected because acceptance will mean that the total cost of the purchased part will come to Rs. 13, i.e, Rs. 10 (Purchase Price) plus Rs. 3 (fixed cost which cannot be saved if production is suspended). However, in arriving at a final decision